BEIJING/SHANGHAI (Reuters) - China's top steel producing province Hebei is under pressure to slash capacity by a fifth by 2020 as part of a new plan to eliminate small private mills and rein in overcapacity, said an official with direct knowledge of the proposed guidelines.

Bringing Hebei's fragmented steel sector under control has long been regarded as the key to China's efforts to strengthen its big state-owned steel firms, curb overproduction and improve its pricing power in the global iron ore market.

China, the world's biggest iron ore importer, has blamed hundreds of small private steel mills for keeping prices of the steelmaking raw material high by expanding capacity even when demand for steel is relatively weak.

Hebei could be ordered to consolidate the sector under 15 large steel firms and slash capacity by at least 50 million tonnes to around 200 million tonnes, the official told Reuters on Wednesday.

The 15 companies are likely to include the Hebei Iron and Steel Group HEBEIH.UL000709.SS, already China's biggest steel conglomerate, and the Shougang Group 000959.SZ which relocated to Hebei from Beijing, local media reports said.

The guidelines are likely to be submitted to the cabinet for approval soon, said the source who did not want to be named because he was not authorised to speak to the media.

Hebei produced around 172 million tonnes of steel in 2012, about 24 percent of the national total. But some analysts estimate that its total production capacity stands at close to 300 million tonnes, about 30 percent of the national total. China is the world's top steel producer and consumer.

The China Iron and Steel Association has identified overcapacity as one of the industry's main problems, but Hebei has traditionally resisted attempts to impose order on the sector as it is a major source of revenue and employment.

Hebei created the Hebei Iron and Steel Group in 2008 after fending off a plan that would have seen its flagship enterprise, Tangshan Iron and Steel, subsumed by Beijing's Shougang.

CLOSING SMALL MILLS

China said earlier this year that it would implement measures to encourage mergers in the steel sector and that it aims to bring 60 percent of total capacity under the control of its top 10 mills by 2015.

It also plans to winnow down the number of small mills by using tougher environmental regulations, such as banning new steel projects in big cities and imposing production caps in regions like Hebei.

Hebei has already moved hundreds of small mills out of major cities and forced plants to install equipment to cut dust, but any further move to beef up requirements to curb pollution is likely to be resisted.

"I personally think the likelihood of adopting more draconian measures is small," said Jiang Feitao, a policy researcher with the China Academy of Social Sciences, who has studied the environmental burdens on Chinese steel mills.

"Currently, the operating conditions of the whole steel sector are very tough."